An uncertain future beckons refiners in the US and elsewhere as stocks pile up amidst near-zero demand. Image Credit: AFP

New York: The day started like any other gloomy Monday in the oil market’s worst crisis in a generation.

It ended with prices falling below zero, thrusting markets into a parallel universe where traders were willing to pay $40 a barrel just to get somebody to take crude off their hands.

The move was so violent and shocking that many traders struggled to explain it. They grasped wildly at possible causes all day long - had some big firm got caught wrong-footed? Or were inexperienced retail investors flummoxed by a market quirk? - but had no tangible evidence of anything to point to.

West Texas Intermediate futures have been the benchmark for America’s oil industry for decades, seeing the market through booms, busts, wars and financial crises, but no single event holds a candle to this. By the end of trading, the contract had slumped from $17.85 a barrel to minus $37.63.

“Today was a devastating day for the global oil industry,” said Doug King, a hedge fund investor who co-founded the Merchant Commodity Fund. “US storage is full or committed and some unfortunate market participants were carried out.”

In a world of its own

In one way, the negative plunge was just an extreme glitch as traders prepared for the expiry of the contract for delivery in May. Elsewhere, the market proceeded as normal - Brent futures, the benchmark for Europe in London, ended the day down sharply, but still above $25 a barrel. WTI for June delivery changed hands at $20 a barrel.

But the negative prices also revealed a fundamental truth about the oil market in the age of coronavirus: The world’s most important commodity is quickly losing all value as chronic oversupply overwhelms the world’s crude tanks, pipelines and supertankers. Ultimately, traders were left desperate to avoid having to take delivery of actual oil because nobody needs it and there are fewer and fewer places to put it.

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Storage terminals like this one in Russia are filled to the brim with unwanted oil. In fact, US refiners are taking in crude only if they are being paid upfront.

Need for deal to work

Despite the OPEC+ deal to cut 10 per cent of global production, the oil market’s crisis is worsening. The rout will send a deflationary wave through the global economy, complicating the task facing central banks trying to keep economies afloat as the pandemic continues to paralyze business and travel worldwide.

The price collapse could redraw the global map of power as petro-states like Russia and Saudi Arabia, which enjoyed a resurgence over the last 20 years thanks to an oil windfall, see their influence diminished. Exxon Mobil Corp., Royal Dutch Shell Plc and other oil giants are ripping up business plans, desperate to preserve cash.

What's the WTI?

WTI is the world’s most traded financial oil contract, a benchmark followed from Zurich to New York to Tokyo. But when each month a futures contract nears expiry and traders roll their positions into further-out contracts, the real, physical world of WTI becomes very small - centered on Cushing, an oil town in Oklahoma where a massive hub of pipelines and storage tanks serves as the actual delivery point for barrels.

In the past three weeks, crude has been flowing into Cushing at a breakneck speed, averaging 745,000 barrels a day and taking in more oil than a medium-sized European nation like Belgium consumes. At that rate, the tanks there will be full before the end of May, something that has never happened before.

What happens when an ETF changed its mind

The days before expiry are often volatile as traders make the shift from a paper to a physical market. Until a few days ago, the May contract had been supported by huge financial flows by retail and institutional investors pouring money into oil through exchange-traded funds (ETF).

The largest crude ETF, known as the US Oil Fund, received billions of dollars in fresh funds in recent weeks, accumulating a fifth of all the outstanding contracts in the May futures contract. But last week, it rolled its position into the June contract, and evaporated from May. Without the fund, the contract was abandoned to the the forces of physical supply and demand.

More on oil glut

As the market opened early in Asia’s Monday morning, the May contract traded at $17.85. As New York traders were firing up workstations in their makeshift home offices, it was below $15.

Then prices really started to slide, making history all the way down. By 8am New York time, the decline had reached 37 per cent, the biggest intra-day drop since the futures started trading in 1982. At around 11am, it passed the low of $10.35 set in the oil bust of 1998. About an hour later, it took out $10 a barrel.

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A US refinery in California... These are dire times for US oil industry as excess supply brings oil futures come crashing down into negative territory. Image Credit: AFP

No one was buying

When CME Group Inc., which runs the exchange where WTI futures trade, said prices would be allowed to go negative, the selling accelerated. By 1:50pm, the contract was below $1 a barrel. Less than 20 minutes later, prices went below zero for the first time and just kept falling.

“No bids. Mental!,” said one trader at a top merchant in a vain attempt to explain the collapse as prices went negative.

“No bids; not a single bid,” said another one in London.

“Ridiculous,” said a third senior trader in Geneva.

Retail traders were likely sitting on long positions coming into the week and were forced to liquidate them, which would be consistent with the sell-off accelerating in the 30 minutes ahead of Monday’s close, Goldman Sachs analysts including Damien Courvalin theorized.

The contract settled at minus $37.63, a drop of $55.90. And there’s still another day of trading to come before it finally expires.

“The May crude oil contract is going out not with a whimper, but a primal scream,” said Daniel Yergin, a Pulitzer Prize-winning oil historian and vice chairman of the research and information company IHS Markit Ltd.

Even discounting the oddity of the May contract’s plunge into negative prices, the world of physical oil suggests widespread pain.

Pay upfront

Many refineries and pipeline companies told producers on Monday that they would only take their oil if they were paid. The daily price bulletin from Enterprise Products Partners LP, one of America’s largest pipeline companies, showed negative prices for all of the crude it buys. Another giant, Plains All American Pipeline LP, told producers the same.

Rude wake up call

Bob McNally, a consultant and oil historian, said the energy market was getting “reacquainted with how the price mechanism for oil works” - and why “for most of oil history, the industry and governments strive to stabilize prices through supply control, be it a tolerated cartel, government regulation, or both.”

The OPEC+ coalition of oil producing countries has failed to stop the rout. Saudi Arabia, Russia and other producers announced a week ago an historic deal to cut global production by nearly a tenth, or 9.7 million barrels a day, from May. The US, Canada, Brazil and others have said their own production is also falling as companies stop drilling new wells.

For Trump, who personally brokered the OPEC+ deal, negative prices means more trouble in the U.S. oil patch. Pressure is building within the Republican party to use trade barriers to save the shale industry, including placing tariffs on foreign oil.

Trump responded to the negative prices at a White House press conference Monday with plans to fill the spare space in the Strategic Petroleum Reserve and by saying he would look into a proposal to stop shipments of Saudi Arabian oil that are currently en route to the US.

But he shrugged off the larger impact, calling it “largely a financial squeeze” that would be that would be over in the “very short term”.

But the market - negative prices and all - isn’t waiting for OPEC to cut production, or for tariffs to slow imports. Rather than being an isolated event, Monday’s unprecedented oil market plunge serves as a warning of more pain to come.

“If global storage worsens more quickly,” veteran Citigroup oil analyst Ed Morse said, “Brent could chase WTI down to the bottom.”